BST: Outlook Has Changed But Income Remains The Same

seekingalpha05-03

BlackRock Science and Technology Trust (BST) has a high dividend yield of 8.6% that is covered from short-term & long-term capital gains generated from market volatility.While the price trades at a ...

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The original thesis was that interest rate cuts would serve as a catalyst for price upside. However, as of the latest Fed meeting, Jerome Powell has made it clear that rates are to remain unchanged for the foreseeable future. With inflation still coming in higher than expected combined with a strong labor market, there is no requirement for this sort of stimulus yet. Therefore, the Fed remains patient as more economic data rolls in as time passes so that they can continue to assess the situation. Data by YChartsSince the date of my last published article, BST has still managed to provide a total return of 7.59% because of the consistent distribution. While the outlook with interest rates may have changed and created an element of uncertainty, there's a silver lining to this. Since interest rates are likely to remain higher for a longer period of time, this increases the probability of increased market volatility since investors will likely be very reactive to what the Fed will do next. As we've seen recently, the markets are shaken every single time Jerome Powell takes the stand. The closed-end fund also provides large exposure to tech-based companies while simultaneously providing a monthly dividend distribution. The current dividend yield is 8.6%, which makes it attractive for investors nearing or at retirement. Even if you aren't nearing retirement, BST if a great way to add splashes of income to your portfolio. In addition, the new portfolio weighting increases the possibility of additional price upside being captured in a tech bull run. BST is attractive from a cost perspective as well. The current expense ratio sits at 1.09%. The actual management fee, however, is only 1%, while the remaining 0.09% is classified as an \"other expense\". Other expenses typically include operating related costs. This is low considering the fund also includes an option writing strategy to help boost the distribution. Approximately 33.5% of the portfolio is overwritten by call options. Updated Portfolio Since my last coverage, there have been some shifts in weight within BST's holdings. This shift has increased the exposure to companies that have been outperforming earnings expectations and growing more rapidly than anticipated. This rebalancing sets the portfolio up to capture additional upside if interest rates are, in fact, cut this year. For transparency, I have compiled those adjustments in the table below and included a column that shows the weight difference compared to the last time I covered BST. BST's main focus is within technology as the fund is mostly composed of exposure to software, semiconductors, and tech hardware and equipment. These three sectors make up approximately 77.18% of the total portfolio of holdings. BST primarily focuses on large cap companies with market caps greater than $10B, amounting to 79% of the fund. Small caps make up 20% of the portfolio and the remaining 1% consists of mid-cap companies. When you look at it this way, BST's strategy seems to be sticking with already established large caps while simultaneously bettering on the growth of small caps that are not as established in their growth potential yet. We can see that the largest position is now NVIDIA (NVDA), followed by Microsoft (MSFT) and Apple (AAPL).   Company Portfolio Weight (%) Weight Difference (%)   NVIDIA Corp (NVDA) 11.74% +4.67   Microsoft Corp (MSFT) 9.86% -0.76   Apple (AAPL) 8.09% +1.77   Broadcom Inc (AVGO) 3.33% +0.92   Cadence Design Systems Inc (CDNS) 2.94% -   Meta Platforms Inc Class A (META) 2.81% +0.58   ASML Holding NV (ASML) 2.77% +0.52   Amazon (AMZN) 2.20% -0.23   Mastercard Inc Class A (MA) 2.42% +0.25   Tesla Inc (TSLA) 1.97% -   Click to enlarge I believe that these small weight changes will allow BST to capture more upside potential during a strong tech bull market. For example, Nvidia remains highly volatile, seeing a price gain of over 190% in only a 1-year time span and currently trades at a P/E ratio of 33x earnings. NVDA trades at a standard deviation rate of 3.58x because EPS growth year over year sits at 585%. With the general expectation of NVDA leading the AI market to continue, BST is set to benefit even more from any upside momentum through its increased exposure. The total number of holdings within the portfolio now sits at 101. While the technology sector (XLK) currently underperforms the S&P 500 (SPY), this can likely be attributed to the mixed batch of earnings and the higher interest rate. I view this as an opportunity to continue adding shares while performance slumps and volatility remains high. Once market conditions stabilize, BST gives you exposure to these tech companies with price targets that indicate major upside potential. Data by YChartsFor example, here are some of the average Wall St. price targets for the top holdings within BST.  NVIDIA (NVDA): $999 per share, upside potential of 20.3%. Microsoft (MSFT): $477 per share, upside potential of 20.7%. Broadcom (AVGO): $1,500 per share, upside potential of 20.7%. META (META): $521 per share, upside potential of 18.7%.  Once market conditions become more favorable, I believe these price movements upward will allow BST to also partake in the gains. When I say market conditions, I am mainly referring to the interest rates that have been weighing on the tech sector. Many tech companies rely on debt financing to fund innovations, projects, and developments that can bring in big money. With rates sitting at highs, there are a lot less innovative products hitting the market. Companies are less willing to take risks because the debt they acquire is no longer cheap, which means that failure of new initiatives will ultimately be more impactful to the company's value. I believe this applies to BST since most of the tech leans towards tech. In combination of higher rates, inflation has also come in higher than expected. High levels of inflation stunts regular consumer spending, which further incentivizes lack of risk taking within the sector. When consumers become more defensive with their spending, we see lower volumes going toward some of these tech products, such as Meta's VR headset or Apple's (AAPL) vision pro goggles. When inflation starts to cool down, we may see increased activity in spending once again, which could fuel the demand for further tech innovation. Adding while the share price currently sits around pre-pandemic levels is a real opportunity here. We can see that the price only sits at a slight 2% premium over the pre-pandemic levels and the price spiked by nearly 80% at the peak of 2021 before declining down to current levels. Data by YChartsYou may be asking yourself: \"why not just invest in these stocks directly then?\" Well, if you desire income, these stocks as individual holdings wouldn't produce enough cash flow without huge upfront investments. As we can see, the dividend yields on each of these are suboptimal for someone that needs income to fund their retirement or pay for expenses. Even with $1M invested into each, the income received is not ideal. With $1M invested, here is the annual dividend amount you would receive.  Nvidia: $200 annually. Current dividend yield is 0.02%. Microsoft: $7,600 annually. Current dividend yield is 0.76%. Broadcom: $16,900 annually. Current dividend yield is 1.69%.  For comparison, $1M invested BST would yield you over $86,0000 annually, and you'd be getting those distributions on a monthly basis. $1M in BST would net you more dividend income than if you had $1M invested in each of the 3 previously mentioned stocks. Best of all, it would be sustainable and grow over time. While the previously mentioned price targets serve as a great reference point, it ultimately comes down to your individual need as an investor. Do you need the guaranteed income now, or do you prefer to wait for the possibility of price appreciation later? High-Interest Rates & Higher Dividend Income In relation to interest rates, I believe that BST will be able to efficiently capitalize on this higher period of volatility (VIX). This increased level of volatility can translate to higher capital gains for the fund managers. We did see the distribution increase up from $0.2260 per share back in 2021 when volatility was off the charts. Shortly after this, we saw rates rise at a very rapid pace. We can see the inverse relationship here when rates started to change. When rates were cut near zero in response to Covid, the price of BST took off to new all-time highs. Once rates started to rise in 2022, the price came back down to the pre-pandemic levels. Now that the price has somewhat stabilized, I find this to be an opportunity. Now that the expectation of rates being cut changed, I think it's a great opportunity to begin accumulating shares before the price moves upward. For income focused investors, capital appreciation comes second. With a Close End Fund like BST that has the main goal of providing income, this environment is actually more favorable for us as investors. We get an extended timeline to build out a strong income focused position. Since the distribution is so high, we are also capturing a solid total return profile over time. Data by YChartsAs of the latest declared monthly dividend of $0.25 per share, the current dividend yield sits at 8.64%. Pulled directly from the 2023 distribution breakdown, we can see that the distribution is funded from short-term and long term capital gains. Unlike most BDCs (business development companies) that may have a focus on tech exposure, this distribution is not funded by the NII. For the month of April specifically, though, the entire distribution was funded by long term capital gains.   Fund Name Ticker Net Investment Income (NII) Short-Term Capital Gains Long-Term Capital Gains   BlackRock Science and Technology Trust BST 0.00%  49.26% (FY 2023)   50.74% (FY 2023)    Click to enlarge To test the dividend income growth over time, I ran a back test with Portfolio Visualizer. Assuming an original investment of $10,000 and an annual funding amount of only $1,200 ($100 a month), your income would have grown substantially. Since the fund was created in 2014, we will start with the first full-year data of 2015. In year 1, your dividend income would have amounted to $742. Fast-forward to 2023 and your total dividend income would now be nearly $5,000 annually while your position size would now be worth over $60,000. Portfolio VisualizerValuation BST currently trades near fair value, with a very slight discount to NAV (net asset value) of only -0.2%. While the average discount to NAV is closer to -0.69%, I still believe this to be an attractive entry point. This is because the NAV has continually grown over time since inception. When a CEF has a NAV that is consistently growing, initiating or adding shares to your position while the price is trading discounted is most ideal. Taking a look at the chart below, we can see that the price and NAV closely follow each other for BST. Simply put, a growing NAV means that the CEF has been able to consistently earn more than the distribution and grow over time. While we aren't in an environment that can support extreme growth like we saw in 2021, I believe that rate cuts will be the first catalyst to get us back to that. When rates are lowered, this will give tech companies access to cheaper debt capital. This means they will be able to assess funding at cheaper rates and fuel growth initiatives and pour capital into research and development.   CEF ConnectSo while the current discount does not sit as low as it did on my last coverage of BST, I believe that the value derived from here is bigger than a simple discount to NAV reference. A lower interest rate is great for tech all-around, as it can also translate to higher consumer spending towards the tech sector. When the cost of capital is lower, tech companies may be more willing to invest in more disruptive and innovation technologies to drive results and growth. In the current environment, it seems like companies are generally focused on efficient capital management and being a bit more cautious. Referring to the previous NAV / price chart, we can see that the NAV has come back down to the pre-pandemic level and even looks like it has failed to grow. This can likely be attributed to the fact that valuations have come back down since the peak in 2021. In addition, the absence of NII contributing to the dividend distribution also means that the fund has to tap into the capital gains to fuel the distribution. As a result, NAV growth can remain limited over time if NII remains missing from the equation. The likelihood of NII ever forming a portion of the distribution lies on whether interest rates come down. Higher rates can create thin margins between the cost of capital and the interest income received. This means that the growth of the NAV can be limited if the assets are always being tapped to fund the distribution. Downsides A prolonged period of higher interest rates may make it difficult for the NAV of BST to gain any traction for growth. As valuations of tech companies are a bit more conservative, a longer period of this current environment would mean that we could see negative or no price upside. In addition, if volatility slows down, the distribution may need to be funded from ROC (return of capital). There are some instances of this happening in the past, like in December for example. In December 2023, the entire distribution was made up of ROC. In this instance, ROC is clearly stated as a return of investor's capital when capital gains and NII are not enough to support the distribution. While recent distributions have not consisted of ROC, it's something to keep an eye on. ROC can be destructive to NAV growth and over an extended usage period. In addition, if you are after total return, then BST may not be the best investment for you. We can see that BST actually underperforms peer CEF Columbia Seligman Premium Technology Growth Fund (STK) in total return since inception. BST has also underperformed Invesco's QQQ Trust (QQQ), which is not income focused. While BST did have brief moments of outperformance over both of these alternatives, the spread between them seems to have increased dramatically after the pandemic drop in 2020. So underperformance is a possibility here based on the historical data. Data by YChartsTakeaway BlackRock Science and Technology Trust (BST) offers instant exposure to the tech sector while providing a high yielding monthly distribution. BST is best utilized by investors that are focused on income generation more than anything else. My previous coverage banked on the thought of interest rate cuts being on the horizon, but that has now changed. Even though the outlook is different now, I believe this only presents an opportunity for additional share accumulation while the value stays suppressed.  NAV has consistently grown over time, and I anticipate this growth continuing once rates do finally get cut. Meanwhile, the portfolio is still solid and distributions have been funded from short & long term capital gains rather than return of capital. The dividend income growth over time can provide income investors with the income needed to fund lifestyle expenses. Therefore, I stand by my Buy rating.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2432957282"}